Under the Energy Policy Act, enacted in late 2005, many energy-incentivizing tax benefits were created. These included, among other things:
• A $2,000 tax credit for homebuilders who built and sold energy efficient residential units.
• Wind, geothermal, closed-loop biomass
• Energy efficient appliances
• Personal credits for energy efficient homes
• Many more (read about them all at the Database of State Incentives for Renewables and Efficiency)
Many of those incentives are indeed “tax credits” for renewable energy and sustainable energy efficiency. This means that every dollar of tax credit that you are entitled to take due to meeting the threshold criteria of the statutes at issue, reduces your tax liability by the same amount. If you calculate your taxes for the year and you owe $100,000 in taxes at the end of your calculations, a “tax credit” of $50,000 would reduce that tax bill to only $50,000.
On the other hand, a “tax deduction,” which is what is being offered under the Energy-Efficient Commercial Buildings Tax Deduction (also known as Section 179D), is only worth a fraction of the dollar amount of the deduction. To calculate what a tax deduction is worth, you need to multiply the amount of your deduction, times your marginal rate of income taxation.
Putting aside your state rate of taxation, let’s assume that you have a taxable income of after all other adjustments of $500,000 and your tax rate is 35%. You would be required to pay $175,000 in taxes. If you were entitled to a tax deduction of $100,000, you would not reduce your tax liability by $100,000. Instead, you would reduce your taxable income by $100,000. As a result, you would now have a taxable income equal to $500,000 minus $100,000 = $400,000. Now, your tax liability would be that new number multiplied times 35% or $140,000. The net benefit to you would be $35,000. Another way to arrive at the same number obviously would be to simply multiply your deduction of $100,000 times your marginal rate of 35%.
In the context of the Energy Policy Act tax deductions for energy efficient commercial buildings, this is an important distinction to make when evaluating whether to pursue a study to secure the available tax deduction. There is a cost involved in obtaining the certification needed to claim the 179D tax deduction. In order to evaluate whether that cost is warranted (is there enough return on your investment), be sure to deduct the cost of the engineering fees needed to accomplish the result, from the amount of the benefit of the study, not the amount of the tax deduction.
Engineered Tax Services have helped commercial property owners and architects generate millions of dollars worth of tax deductions under the Energy Policy Act. If you need help in determining the cost effectiveness of a study for your projects, require further information on the Energy Policy Act and the 179D deductions, or regulations regarding the guidance on Commercial Building Deductions, please contact the author.
This article was written by John Cummings, Executive Strategic Officer at ETS, as well as General Counsel for ETS. John is also a partner at the New Jersey, New York and Florida-based law firm, Nicoll, Davis and Spinella.